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Some joint tests of market efficiency: The case of the forward premium

  • Baillie, Richard T.
  • McMahon, Patrick C.
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    The rational expectations model of the term structure is applied to the forward premium on foreign exchange. The model has been previously considered by Hakkio (1981) as a test of a form of market efficiency. Rejection of the model can be due to a failure of the rational expectations hypothesis of the term structure of either the domestic or foreign bond markets, or due to a breakdown of covered interest parity. One- and three-month forward premiums, for three separate currencies, are modeled as unrestricted vector autoregressions, and parametric expressions are derived for a Wald test statistic and an asymptotically efficient two-step estimator of the restricted model. The resulting Wald and Likelihood Ratio statistics give rise to a rejection of the model for all three currencies.

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    Article provided by Elsevier in its journal Journal of Macroeconomics.

    Volume (Year): 7 (1985)
    Issue (Month): 2 ()
    Pages: 137-150

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    Handle: RePEc:eee:jmacro:v:7:y:1985:i:2:p:137-150
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